Q3 2024 CAE Inc Earnings Call
Defence performance was lower than the third quarter last year as we continued to retire risk on a group of distinct legacy contracts, which Sonya will describe in more detail in her section.
We booked orders for $429 million for one <unk> nine times book to sales ratio give.
Giving us a $5 6 billion defense backlog.
Which is up from $5 1 billion in Q3 of last year.
They include a maintenance contract with United States Air Force for the F 16 train devices.
And the continuation of training services on the C 138 transport and KC 135 tanker platforms.
Defense orders also included an option exercise for the U S Army for fixed wing flight training and support services at the CAE Dothan training Center.
With that I'll now turn the call over to Sonya, who will provide you additional details about our financial performance.
Sonya: Thank you Mark and good afternoon, everyone Consol.
Sonya: Consolidated revenue of $1 9 billion with 13% higher compared to the third quarter last year, while adjusted segment operating income was $145 1 million.
Sonya: Compared to $156 8 million in the third quarter last year.
Sonya: Our quarterly adjusted EPS was <unk> 24 cents compared to 27 in the third quarter last year.
Sonya: We incurred restructuring integration and acquisition costs of $22 $5 million during the quarter relating to the Air Centre acquisition.
Spencer related to their center integration, which is progressing as planned or expected to wind down by mid fiscal 2025.
Net finance expense this quarter amounted to $52 4 million, which is up from $47 $1 million in the preceding quarter and up from $47 7 million in the third quarter last year. This is mainly the result of higher finance expense on lease liability.
Sonya: Income tax expense this quarter was $8 2 million for an effective tax rate of 12%. The adjusted effective income tax rate was 15%, which is the basis for the adjusted EPS.
Sonya: As Andrew indicated at the outset healthcare is now classified as a discontinued operation and our net loss from discontinued operations was $1 $9 million this quarter compared to a net income from discontinued operations of $2 1 million in the third quarter of fiscal 2023.
Sonya: The decrease to the third quarter of fiscal 'twenty, three was mainly attributable to transaction costs of $2 2 million incurred in the third quarter of fiscal 2024 in relation to the expected sale of the healthcare business.
Sonya: Net cash from operating activities this quarter was $220 8 million.
Sonya: Compared to $252 4 million in the third quarter of fiscal 2023 free cash flow was $190 million compared to $239 8 million in the third quarter last year. The decrease was.
Purcell.
Action is a milestone for us the reinstatement of cash returns to shareholders and the board now actively evaluating options in terms of form quantum and timing of such return.
We're prioritizing a balanced approach to capital.
Including funding accretive growth continuing to strengthen our financial position commensurate with our investment grade profile and returning capital to shareholders.
Now I'll turn it to our segmented performance.
In civil third quarter revenue was up 20% to $622 1 million compared to the third quarter of last year and adjusted segment operating income was down 5% to $124 2 million.
Versus the third quarter of last year for a margin of 20%.
This is right in line with our expectation for the quarter and our full year outlook for civil.
There were a few differences in the quarter compared to last year, mainly from the mix of accumulation products revenue and flight services activity, which offset the higher training your life and increased volumes from recently deployed simulators in our network.
Sonya: In defence revenue was up 4% to $472 4 million, while adjusted segment operating income was down 18% to $20 9 million.
Sonya: Giving us an adjusted segment operating income margin of four four.
Sonya: Okay.
The defense margin. This quarter included the negative impact of the ongoing retirement of eight <unk>.
Sonya: Legacy contracts the completion date, mainly within our next two fiscal years, what these contracts, having common and why we are monitoring them separately.
Sonya: <unk> entered into prior to the COVID-19, pandemic and our firm fixed price infrastructure with little or no provisions for cost escalation. These contracts are only a small fraction of the business that are disproportionately impacted overall defense profitability as they have been the most significantly impacted by execution difficulties and the broader economic headwinds.
As discussed in past quarters, such as the compounding the deflationary pressures and disruptions to supply chain and labor to be.
Sonya: More site the execution of these eight legacy contracts have an approximate two percentage points negative impact on the defense segment operating income margin in the third quarter.
Sonya: With that I will ask Marc to the way forward.
Marc: Thanks Danielle.
Marc: Looking ahead at each one of our Sigma.
Sonya: Civil.
Marc: We expect to continue our above market growth momentum for trading of the <unk> services solutions.
Marc: Underpinned by strong secular passenger traffic growth continued success penetrating shirt for any market.
Sonya: At a high level of demand for pilots pilot training across all sectors.
Sonya: For the current fiscal year, we continue to expect civil to deliver adjusted segment operating income growth in the mid to high teens percentage range.
Sonya: On a year ago.
Sonya: We continue to expect the civil adjusted segment operating income margin compete in a range of fiscal 2023, which naturally implies an especially strong margin for civil in.
Sonya: In Q4.
Sonya: In addition to growing our share in training and expanding our position in digital play services.
Sonya: We expect to maintain our leading share of full flight simulator sales and to deliver approximately 50 for the year.
We have considerable headroom for growth for this niche market.
Sonya: And our continued positive momentum.
Sonya: Underscores the strong demands precede highly differentiated trading in flight services solutions, and our ability to win share within this larger secular growth markets.
Sonya: Turning to the us.
Sonya: We will continue transforming our business.
Sonya: Finishing our backlog with more profitable work and by retiring the legacy contracts that you highlighted.
Sonya: These two trend lines remain positive weeks.
Sonya: Culminate substantially.
Sonya: A substantially bigger and more profitable business.
Sonya: Since amending the scale and capabilities of the defense business approximately two years ago.
Sonya: We've grown the defence backlog by over 20%.
This sets us up very well for sustainable growth and includes a strategic and generational wins on next gen platforms that we've talked about in recent quarters.
Sonya: Still to come and not yet in backlog are the Canadian facts and our pass programs that are occurring contract negotiations and are also generational and slides.
Sonya: The progress that we're making that we've been making to replenish the backlog with higher quality profitable program is the best indication of what the future holds for fees defense.
Sonya: Or would it not in absolute dollars timeline of bids and proposals outstanding we continue to see positive signs of the transformation.
Sonya: And I've looked at the remainder of 2024.
Sonya: We expect the fed to keep winning high quality profitable programs and in the fourth quarter. We expect to further accelerate the retirement of risks associated with the legacy contracts to the extent that we can.
Sonya: Clearly, we want to get them behind us as soon as reasonably possible and we're closely monitoring monitoring them as a separate group.
Sonya: We're highly focused on execution and expect to substantially reduce the negative impact from these legacy contracts.
Sonya: Over the next six to eight quarters as Youre gradually retire.
Sonya: The extent to which the ongoing risk retirement on these programs might impact defense margins in the coming quarters really depends on the actual timing of program closeouts at our ability to mitigate these risks.
Sonya: Our dedicated teams are working to revise re baseline of some contracts.
Sonya: <unk> adjustments on others and to buying program efficiencies overall.
And foresee overall, we continue to be highly encouraged by the demand backdrop that we're seeing in all segments and the growth that we expect by harnessing our global market and technology leadership.
And the power of one fee.
Sonya: These factors combined with highly focused execution and a solid financial Foundation put 10 continued good growth momentum in the next future for Keith.
Speaker Change: And with that I'll. Thank you for your attention, though right now ready to answer your questions.
Speaker Change: Thanks, Mark operator, we'll now open.
Speaker Change: The members of the investment community.
Speaker Change: Thank you.
Speaker Change: Ladies and gentlemen, if you would like to register a question. Please press the one four on your telephone you will hear three problem to acknowledge your request.
Speaker Change: If your question has been answered and you would like to withdraw your registration. Please press. The one followed by the three one moment. Please for the first question.
Fatty Shovel: Our first question comes from fatty shovel.
Fatty Shovel: BMO. Please proceed.
Fatty Shovel: Thank you operator.
Fatty Shovel: Thanks, guys.
Fatty Shovel: So.
Fatty Shovel: Yes.
BMO: Trying to kind of see how to best think about the trajectory of defense margins.
BMO: Mark you mentioned.
BMO: The focus on accelerating the retirement.
BMO: Of risk associated with these legacy contract.
BMO: Which I understand that this quarter the impact was 200 basis points.
BMO: And goods also.
BMO: The idea that the backlog.
BMO: Growth in topline growth.
BMO: Kind of implementing higher margin contract should be margin accretive as we go forward.
BMO: Does does the margin.
BMO: Starts to improve from the current level that we're at right now or.
Or are we stuck at these kind of lower level for some time.
BMO: The other thing what exactly you mean by accelerating the retirement of Bob you're able to to exit these contracts earlier or is it a cost action that you're taking to improve.
BMO: Improve the performance of these specific contract.
Speaker Change: Okay. Okay luck gluts their fatty but fair questions for sure look younger to go right to the NGA last question, because I remember that right off the bat.
Speaker Change: When we talk about.
Speaker Change: Accelerating retirement.
Speaker Change: What we're really talking about here is that we're likely going to incur potential costs.
Speaker Change: On a faster.
Speaker Change: Yes.
Speaker Change: Put it this way faster timeline as we worked through the.
Speaker Change: Execution on these contracts.
Speaker Change: Or even take actions like for example, co.
Close out some of these contracts ahead of time.
Speaker Change: And I'll give you examples of that but let me just end it right now.
Speaker Change: Because whatever we do we can offset it by mitigating efforts that we try to limit the costco, but let.
Speaker Change: Let me just basically tell you some of these things that we might do look.
Speaker Change: We might decide to D scope of contract and I'm talking about these eight legacy contracts that we've talked about we might decide that this global contract what does that mean that means we call yeah.
Speaker Change: <unk>.
Speaker Change: And we're looking at this in at least one specific contract.
Speaker Change: Potentially crude liquidated damage.
Speaker Change: If that makes sense for us to cut off of future tale of programmatic risk on that program, so better to take that pain now to take a lot. More later, if you don't want them, but of course that depends on negotiations specifically that we have on <unk>.
Speaker Change: Underway under the with that specific customer other things, we might do as we might agree.
Speaker Change: To alternate alternative terms or schedule and then we're looking at that on some of these programs as well.
Speaker Change: We might incur a full one contracts in the denim and engineering change proposal.
Speaker Change: One of these contracts they were looking at that and then that's what potential some of these contracts that we will do is give us more work in which case, we can spread the cost around over a bigger quantum lessening the impact of any individual product. So we're doing all of that.
Speaker Change: So if I look back to your maybe the margin question real.
Sony: Real quick go to Sony on this one.
Sony: Look we saw that we took.
Sony: About 200 basis points for the quarter analytical suddenly on that without going too deep on that one but.
Sony: There's going to be variability from quarter to quarter for the reasons I talked about this is not going to be linear because we are taking active steps to try to retire. These contract as soon as we can especially retired the risk take the right actions now mind, you were never going to give up on.
Sony: On a customer that's not what we you will see we will deliver the products and services that we committed to a customer that <unk> culture and don't forget that's the mission that we have in defense, we were not going to do that but.
Sony: I mean, that's the way I look I would look at these centers.
Sony: Before I give it to Sony is the one thing I would tell you.
Sony: Is there is nothing new here.
Sony: <unk> disclosure that we gave you last quarter in terms of the quantitative what we're trying to do here is to give you a little bit more precision on the number of contracts that are dragging our overseas legacy contract deterioration how long they last and the steps that we're taking.
Sony: Interactively mitigate now maybe.
Stop there to turn it over to you. So can you just expand on the 200 basis at least for this quarter I mean, absolutely. Thanks, Bob Hi, Paddy So what we've done this quarter has endeavored to ring fence. The few contracts that have a disproportionate negative impact on that in doing so.
Bob: As you can appreciate this is a process there's a strict definition and we're committing to continuing disclosure to report back on these legacy contracts and our progress on them. So you can see that in this quarter. There was an approximate impact of 2% 200 basis points this quarter, but by the way. There's also an impact of an under our.
Bob: Absorption of costs needed to achieve scale and support of all of the businesses like R&D and SG&A that can be up to another 100 basis points, So which makes the impact slightly higher at around 300 basis points.
Bob: For Q3.
Bob: Now I can say that the next six to eight quarters will look exactly like that that we're constantly working to all the.
Bob: Currently versus to mitigate these risks and Westwood work with our customers is as Mark has has highlighted so while there will be some variability quarter to quarter. This quarter's impact as a rough baseline of the headwind that we face on average.
Okay. Okay. That's great. So basically you are talking about a scenario where you can take these lawsuits upfront then ultimately.
Bob: Exit.
Bob: Hello.
Bob: Contract risk earlier, so that's what's going to be lumpy.
Bob: The.
Bob: The comment about 100 basis absorption is this tied to.
Bob: Backlog deployment.
Bob: And how quickly you deploy the backlog too.
Bob: Movement in that cost.
Bob: Absorption at all what you mean by that.
Speaker Change: Yeah, as you drive volume and profitability you have a better volume to support all of these costs that are needed to scale and support a business of this size and growing so now at this level there is an under absorption.
Speaker Change: That you can assume has about a 100 basis points added to the other 200 gig quickly.
Speaker Change: Okay. So the timeline of six to eight quarters, that's kind of the most.
Speaker Change: I want to say the pessimistic kind of time line hopefully you can deal with some of these contracts earlier. It takes some of these losses maybe earlier.
Speaker Change: And move on from that.
Speaker Change: Yes, that's definitely what would it be seeking to do.
Speaker Change: Okay. Thank you I appreciate it.
Speaker Change: Yeah.
Speaker Change: Our next question comes from Cameron Dirkson with National Bank Financial Please proceed.
Cameron Dirkson: Okay. Thanks.
Cameron Dirkson: Good afternoon.
Cameron Dirkson: I'll ask a question on the civil business.
Cameron Dirkson: The utilization rate in the quarter.
Cameron Dirkson: It was really strong 76%, which.
Cameron Dirkson: I don't have it going all the way back when it seems like maybe that's one of the best Q3's, you've had.
Cameron Dirkson: I'm just wondering if you could maybe discuss what youre seeing as far as demand across the various training. Our components are you seeing any any changes there or is it continuing to be.
Cameron Dirkson: Drawn in the fourth quarter like we saw in Q3.
Speaker Change: You know what camera, we're seeing very strong demand I can tell you I look out my window here.
Speaker Change: The parking lot material I can tell you is full.
Speaker Change: Saying that but.
Speaker Change: Perversely, that's a pretty good indicator.
Speaker Change: What we see is utilization of our training centers in and that's across all the screening centers I've seen no softening of demand then, yes, we said before.
Speaker Change: As you can do the math, but we fully expect a pretty darn. Good Q4, and we have very good visibility on that because obviously, we're pretty close to the end and we know what is familiar with we have to deliver.
Speaker Change: And again, we have some.
Speaker Change: Very strong bookings in our training center and these days I can tell you nobody's looking at chemical bookings.
Speaker Change: Okay. That's good to hear and just maybe just a very brief follow up to <unk> question. Just on the defense. You mentioned you may be seeking some I guess equitable adjustments I know, there's some you've discussed in the past have you had any success there.
Speaker Change: Are you optimistic at all that Youll get some some relief from your customers with some maybe some pricing adjustments within these these legacy contracts.
Speaker Change: I'm optimistic, but I'm not optimistic on the timing, meaning because I can't.
Speaker Change: I've been wrong every time.
Speaker Change: I can tell you that.
Speaker Change: The bulk of it we've gotten a bit I would tell you about give or take about 10% of what we believe that we are very very strong cases have documented.
Speaker Change: Evidentiary.
Speaker Change: Reported claims into customers, but again there is this depends on so many things that I don't control that and I would tell you. We have made some assumptions I would say conservative assumptions with regard to as we looked at mitigation from some of these legacy contracts that some of that is included but certainly not the full quarter.
Speaker Change: Okay. That's helpful. Thanks very much.
Speaker Change: Okay.
Speaker Change: Our next question comes from Kevin Chiang with CIBC. Please proceed.
Kevin Chiang: Thanks for taking my question.
Kevin Chiang: I know you don't have multiyear guidance or targets of defense, but if I just kind of weak if I rewind.
Let's turn it back to fiscal Q2, and then you provided an update on defense at that point in time, I think the market write it as you'd have around mid single digit EBIT margin.
Kevin Chiang: For the remainder of this year, maybe you get up to higher single digits in fiscal 2025.
Kevin Chiang: Then you can normalize to a run rate.
Kevin Chiang: So to your target of low double digit sometime in fiscal 2026.
Kevin Chiang: Right.
The fact that you haven't changed your through your EPS target I'm, just trying to level set and that's still the trajectory. You think you can do as you roll off some of these contracts or towards affected double digit.
Kevin Chiang: EBIT margin, maybe cloudier here today, given the new disclosure you provided.
Speaker Change: Yes, so clearly there is some dependency on the timing of the risk retirement.
Speaker Change: On those legacy contract and the pace of the new programs ramping up and we're working this has indicated at the same time our outlook remains robust we need to close out on the health care transaction that we expected to do so and by the end of the fiscal year and finalize that impact. That's also will be providing more insight on all of these.
Speaker Change: In Q4, as we usually do.
Speaker Change: Okay, that's oh.
Speaker Change: I'll look forward to that.
Speaker Change: Maybe strategically.
Speaker Change: No.
Speaker Change: You're running about 21.
Speaker Change: These past.
Speaker Change: Few quarters, you've been running kind of low to mid $20 million operating income.
Speaker Change: I'm just wondering do you think the business is big enough to absorb these couple of pick ups, what do I mean by that it doesn't seem like the absolute dollars impact from the legacy contract issues is large, but it's obviously coming off of.
Speaker Change: A smaller base I'm just wondering.
Speaker Change: I mean, this seems to be something you'll always have to deal with and we deal with the government of fixed price contracts.
How do you think about the ability to absorb even small.
Developments does that work.
Speaker Change: That ended up being a little bit more negative than we anticipated and not having any kind of thoughts like margins.
Speaker Change: Where they have the past the past year or so.
Speaker Change: Well I think the way I look at it is.
Speaker Change: What do we tell me the legacy contracts that were dealing with you.
Speaker Change: They're not particularly large individually in terms of either revenue or backlog, but to your point.
Speaker Change: They they they can and they are and they have introduced a disproportionately large cost.
Speaker Change: In a given period as we work.
Speaker Change: As we work through them.
Speaker Change: Especially if you do.
Speaker Change: Active efforts that we have to reach a customer settlements are agreed to change in terms things like that so, but we have to remember as well that the.
Speaker Change: Business is not where it is.
Speaker Change: The size that we want it to be so in the end of the day when you have a hit in any way the corners.
Material impact.
Speaker Change: Because of the small small quantum that you have any absolute number.
Speaker Change: Yes.
That's a fair point, okay. Thank you very much and best of luck as you get closer.
Speaker Change: Yes.
Speaker Change: Okay.
Speaker Change: Our next question comes from James Mechanical with RBC capital markets. Please proceed.
Tim James: Hey, good afternoon, and thanks for having a hum yawn.
Tim James: So my question is with regard to how Youre looking at.
Tim James: Deploying capital in the defense segment.
Tim James: Seems like returns on that business right now that they are below your target.
Tim James: Do you think there is enough room to improve margins to bring returns in defense within all your internal targets or any other things to consider with regard to how you intend.
Tim James: Just deploy that capital that's tied up.
Tim James: Right.
Speaker Change: Yeah, So what I would look at a balanced capital allocation strategy James and the first priority is continue as we are obviously continuing to deleverage and drive through.
Speaker Change: Our flexible balance sheet.
Speaker Change: Is to invest in accretive growth and our top priority is to serve the demand that we see on the civil market and that organic capex.
He is a highly accretive and drives returns of 20% to 30%.
Speaker Change: Incremental pre tax returns within three to four years. So wherever we have those opportunities that is the first.
Our priorities in terms of capital allocation, yes, sometimes we do deploy some capex on the <unk> on the defense side. Ultimately if we are to do so we would expect that to be on commercial terms and driving commercial like.
Speaker Change: Margins.
Speaker Change: Yeah, and then maybe I'll just add to that so again and we've already talked about some of those like for example, the U S Army <unk> contract.
We will be deploying a global 6500 simulator.
Speaker Change: Our existing facilities and the Dolton training center, where we already deliver the fixed wing training for the U S Army.
Speaker Change: And in that case as Tony said, we are because it's a commercial solution, which we're pulling business circa weekend.
Speaker Change: Enter into what's called a commercial contract with U S Army, which of course in that case would be capital that well deploy because it's going to be able to service them.
Speaker Change: With margins more like we get in the kind of civil environment. So you can imagine that's accretive to return. Another example, I would give you that that is a contract that we've talked about for what was previously.
21 contracts, what do you call. It is the F T SaaS contract, where we will be deploying capital to replace all of the simulators used by the U S Army.
Speaker Change: Well Gulfport rockers or no. It is not that again it will be very.
Speaker Change: Accretive capital deployment independence, because we will be able to enter into service contracts on the delivery training curious for me on <unk>.
Speaker Change: <unk> commercial contracts, which are more favorable to us than traditional contracts and defense.
Speaker Change: And then if we look at the book to Bill on the defense side. It came in below one.
You did point to some.
Speaker Change: Unfunded backlog.
Speaker Change: So kind of within that backdrop, how should we be thinking about growth in this segment.
Speaker Change: <unk> ahead is it fair to say you know you expect topline and defense to be higher in fiscal 2025 versus <unk> 24.
Speaker Change: Okay.
Speaker Change: Hey.
Speaker Change: So to your point, the order and to get the <unk> nine.
Speaker Change: It's slightly below one, but I wouldn't look at the overall total total backlog because there is the dynamics of kind of the first year funding and so on so you can see the growth.
Speaker Change: And the backlog that.
Speaker Change: We're expecting some big Q4 Awards, Mark Q4 Q1 Award.
Speaker Change: That Mark spoke about the March Canadian contract that we've been selected and then we're expecting those to come in and that will drive some significant order intake and backlog growth.
Speaker Change: Defenses defensive growth businesses as I've said in the remarks.
Speaker Change: We have 20% backlog growth in last two years and that doesn't include contracts that we've been selected on like the future aircrew training in Canada, Europe, Australia contracts. We missed selected those two contracts are really generational advice, we're not under contract yet. So you got to figure out how to get under contract we expect that to be in the first half.
Speaker Change: For next year, and then we got to turn it over to start turning to revenue. So there'll be timing involved but there's no doubt this is a growth business.
Speaker Change: And sorry, I just got one quick follow up on that if there's.
Speaker Change: The defense side before I turn it over or the low margin contracts that are rolling off the contract you've identified are those EBIT positive I guess.
Speaker Change: As those.
Contracts roll off although they might be accretive to margin is it EBIT neutral or are those are losing money right now.
Speaker Change: We don't necessarily give the details of the contract individually I think it's a mix.
Speaker Change: And so they will be they are not particularly large on the revenue, but have that disproportionate impact on our on the <unk>.
Speaker Change: The cost.
Speaker Change: But I think the best measure to kind of look at it in the margin.
Speaker Change: Okay. Thank you very much.
Speaker Change: Okay.
Speaker Change: Our next question comes from Conor Gupta with Scotiabank. Please proceed.
Conor Gupta: Thanks, operator, and good afternoon, everyone.
Conor Gupta: Maybe just to follow up on defense.
Conor Gupta: <unk>.
Conor Gupta: What has been dedicated theme that you have deployed for these legacy contracts achieved so far if you can give any concrete examples of what is their mandate going forward.
Conor Gupta: Oh mandates of successful execution, although contracts to deliver what we committed to deliver to our customers. That's first and foremost all all of that because that's what these about and we have a critical mission defense, which you know it goes without saying I want to do that is first and foremost and of course deliver it under the best finance.
Conor Gupta: The terms that we can and thats, what theyre mandated so execute on the contracts and get us to that software spending than we can with regards to retirement of risk on those contracts work with our customers to try to establish win wins.
Conor Gupta: Two <unk>.
Conor Gupta: <unk> to shrug off these go through fund.
Conor Gupta: Moves is scheduled to provide us a schedule of the Asia get request for equitable adjustments, where we definitely are entitled to get them because of the extremely high inflationary environment that we've had to disproportionately.
Conor Gupta: It affected our costs those are all the things that are that our team is doing and I would tell you we would.
Conor Gupta: Just put these teams on overnight based teams have been working for some time and they have had good progress in executing and reducing the reducing the burden that we're facing here in defense.
Conor Gupta: You're already we're already seeing the fruits of our labor here, which allows us to give them more precision that would give you today.
Speaker Change: Okay. That's great color, thanks, and if I can just follow up on <unk>.
Speaker Change: Any change in discussion on language from customers from airline customer, especially in light of the <unk> hundred 20 engine issues that we saw recently as well as now the Boeing seven could be selling problems.
Speaker Change: The thing I would tell you is no no because airlines are scrambling to meet the demand that they see out there.
Speaker Change: The impact is real.
Speaker Change: The impact of the engineers can you just talk about Israel, you can have hundreds of airplanes round at any given time would not having some effects or what I.
Speaker Change: I would tell you it hasn't affected our business the airlines.
Speaker Change: We operate with it which is you know a great majority of airlines in the world, but are scrambling to be able to get alternative lift whether it be keeping.
Speaker Change: Other airplanes.
Speaker Change: On station, rather than new ones leasing leasing or was that kind of thing.
Speaker Change: So we're watching that we're also watching the delivery delays specifically because the math is simple right I mean, we've talked about it many times before but for every about 30 narrow body.
Speaker Change: Deliveries.
Speaker Change: Because it's a regulated market is it fills up one simulators work with demand.
Speaker Change: Clearly if this supposed to go on for a long long time, then that would have an effect but for now.
The discussion that we have with customers.
Speaker Change: Bill a lot of unmet demand in this market.
Speaker Change: With regards again to the order intake this quarter I mean, we're talking to a very strong book to bill on top of 20% growth in revenue.
Speaker Change: And what you see there is a testimony to our success and more outsourcing.
Speaker Change: Very very happy to join another marquee customer like air.
Speaker Change: Air, France, KLM, which historically have thought outsourced outsourcing a portion of their premium requirements to us the growth they have a very large contract business aviation so well.
Speaker Change: To me.
Speaker Change: We're seeing no we're basically seeing a softening demand and going back to your question. The conversations we have with.
Speaker Change: Airlines are business aviation customers are essentially like the one I just described.
Speaker Change: Yes.
Speaker Change: Thanks.
Speaker Change: While the timing of it.
Speaker Change: Our next question comes from Bruno <unk> with <unk> capital markets. Please proceed.
Bruno: Yes, thanks, very much and good afternoon.
Bruno: Just to come back on the defense margin, if we strip out the 200.
Bruno: <unk> from the legacy product it implies that the base is running at around six 4%, which is obviously far from double digit level. So could you maybe give us more color on.
Bruno: It seems to be taken to bring the phase two double digit.
Bruno: Is it related to delays in funding is it a matter of scale revenue loss since the acquisition of L. Three.
Bruno: Or are you recruiting caused these days too.
Bruno: To support the high trading environment.
Speaker Change: Yes, perhaps.
Speaker Change: Couple of points first of first time your appointment of the 200 basis points as I as I mentioned earlier on the call.
Speaker Change: The 200 basis points as a reflection of the impact of those legacy contracts, but there's also the impact of the under absorption that we should consider but these are the costs needed to achieve scale business like R&D and SG&A. So that could be another up to a 100 basis points. So I'd use that basis of 200 to 300 in total.
Speaker Change: In addition, as we've mentioned in the past the delay of the ramp up of new expected orders and especially the transformational ones because they move the needle.
Speaker Change: As these start to come in and start that really reflect to the revenues that we spoke to it last quarter. It was 3% its really still minimal representation in their revenue, but 20% of backlog.
Speaker Change: Start to ramp up more materially.
Speaker Change: We expect that the first step up and drive a meaningful impact.
Speaker Change: Okay, and what is the strategy within the defense business now to ensure that you don't run into contract issues like like this in the future.
Well I can tell you but.
Speaker Change: There's a lot of tuition lodge will be live this in the last three years.
Speaker Change: Those lots.
Speaker Change: And there will be implemented.
Speaker Change: I think firstly and foremost which is obvious and we have a lot of commonality with our peers in the defense industry across the board here is were certainly not getting into firm fixed price development contracts, because there's a lot of cases.
What got us into this situation in the first place where you'd have development contracts.
Speaker Change: I get fixed for a price you incur delays because well first of all we went through COVID-19 with everything that goes along with that with regards to.
Part shortages with manpower shortages on top of everything escalating.
Speaker Change: Basically compile an escalation with regards to the deflationary environment, but we have no protected so there was a similar things that obviously, we're not doing that.
Speaker Change: There is other things that we're doing like for example, making sure that we band service contracts.
Speaker Change: Established will be tighter pricing bands. So on utilization. So we don't get caught out that if the customer uses more or less of the demand that we somehow are disproportionately affected.
Speaker Change: I would tell you there's a number of things, but that's what we're doing it in a very tight monitoring of execution at all levels.
Speaker Change: Okay, and just looking at the civil margins reached 20% EBIT margin this quarter, which is a step down versus $2 25, 4% achieve.
Speaker Change: Achieved a year ago, despite having stronger revenue greater utilization rate.
Speaker Change: Could you. Please let us know what what drove that and what makes you confident to achieve the implied 26% EBIT margin in Q4 in order to reach the.
Speaker Change: Uh huh.
Speaker Change: Double digit.
Speaker Change: Growth for the year.
Speaker Change: Okay I'll separate up to say I didn't tell you 26, you said that but hey, Okay. We said you can do the math, but look.
Speaker Change: I think if you go back to what I think what I said to in the last conference call in the last quarter I tried to point to that so I would tell you the margin as I said are there, where we expected them to be and I'll give you. Some of the components here does it vary there's mix is very much at play here and you know we've talked.
Speaker Change: About mixed before and yet this mix looks kind of high end it on the base of it is.
Speaker Change: I would point out last year in Q3, the mix was very favorable from a couple of perspective. It was from our products business and it's also what from.
Speaker Change: Kind of the new segment that we have but not a significant part of our civil which is our software business because last year, we had a lot of what we call very favorable on premise working and I'll tell you what we mean by that and in our software business. We are actively as a strategy.
Speaker Change: Going to a winning contracts we're trying to move customers from on premise work to software as a service. So let me make it you an analogy and that if let's just say on premise where it would be like us in the in the core business to sell simulators just fell simulator you get the revenue to get the card.
Speaker Change: Track.
Speaker Change: Literally very fast.
Speaker Change: Now contrast that with the training market going through a software as a service is kind of like we're doing in training, where basically we're gonna get paid overtime. So.
Speaker Change: From.
Speaker Change: Much better recurring standpoint, much more long term very attractive work, but obviously, it's not it's not going to give you a bit soi bump in one quarter, that's what we see and when we look at the upcoming quarter in Q4.
Speaker Change: We expect that kind of digested that particular dynamic to be very favorable again, and thats really coupled with a number of simulators, we deliver and utilization in our training centers. That's why we're basically saying we expect a strong Q4 Q4, reflecting in the heightened guidance.
Speaker Change: That we gave for civil last quarter.
Speaker Change: Okay, and maybe last one for me if we look at Air Center. It looks like that there was about 1 million of integration and acquisition costs. They can so far obviously, that's all we shouldn't multiple was very attractive and you knew that it would be a two or three year journey.
Speaker Change: Just mentioned that the infrastructure integration will be substantially complete by mid fiscal year 'twenty, but.
Speaker Change: I'm just wondering if you could give an update on the remaining cost to be taken and how much are center could be incremental in terms of margin and whether it's meeting.
Speaker Change: Any color about the return on capital employed specifically so far thanks.
Speaker Change: Kevin I thought when we continue the integration of our customers on our systems to our network and as I mentioned in the remarks, we expect to be done.
Speaker Change: By mid next year, so there's really good great ramp up of migrating our customers out of the.
Speaker Change: Previous network into our network and celebrate.
Speaker Change: <unk> done last quarter, and we expect a lot of great progress this quarter as well so while we won't necessarily kind of give our outlook on the costs, we expect that to be pretty much finished.
Speaker Change: During.
Speaker Change: And the next first half of next year.
Speaker Change: Okay. Thank you very much for the time.
Speaker Change: Yeah.
Speaker Change: Yeah.
Speaker Change: Our next question comes from Tim James with TD Cowen. Please proceed.
Tim James: Thanks, very much good afternoon.
Tim James: Most of my questions have been answered, but I just had one quick one for Sonya just looking.
Tim James: Looking at some detailed here.
Tim James: The depreciation expense in the civil business jumped.
Tim James: <unk> a significant amount in our in the quarter relative to the second quarter I'm looking at in particular, just the sequential change was there any particular reason for that is is this new.
Tim James: The reported the Q3 rate a good proxy going forward.
Well I think the headline is growth right. So we deployed 20 stimulators last year 13 year to date this year and we've on boarded.
Tim James: Overall training center with its Las Vegas, Havana came online this quarter we have.
Tim James: Another extension of our Phoenix Training Center that came online also this quarter, so youll see that draw.
Tim James: Driving that depreciation expense and some of the interest that I spoke to on the lease liability, it's really deployment of new simulators and a new new training centers.
Speaker Change: Okay. So it is just a natural step up then you know in relation to the assets in the business.
Speaker Change: Yeah.
Speaker Change: Great. Thank you very much.
Speaker Change: Okay.
Speaker Change: Yeah.
Speaker Change: Yes.
Speaker Change: Our next question comes from Kristine La work with Morgan Stanley. Please proceed.
Kristine Tan Liwag: Hey, good afternoon, everyone.
Kristine Tan Liwag: Hi, Christine.
Kristine Tan Liwag: Yeah, Hey, Mark I'm you know are you you just reiterated that the the the margins for that for the next quarter I mean, it seems like for <unk> 'twenty <unk> 24 to get to your guidance. It implies about 16% revenue growth for the quarter year over year and margins you know a little bit north of 26% and so you know.
Kristine Tan Liwag: With all the mix headwinds that you highlighted this.
Kristine Tan Liwag: This quarter and it seems like some of that goes away next quarter, how do we think about the run rate for fiscal year 'twenty five is 26% the starting point and how do we think about that Oh for next year.
Speaker Change: Well I'm not going to question your Ma [laughter].
Speaker Change: But we've given you enough, but look we're not guiding for 25 now, but clearly I mean, you look at the order intake that we have the book to Bill that we have and I think you're going to see strong growth.
Speaker Change: Okay.
Speaker Change: Yeah.
Great and Mark in terms of the software business I mean thoughts from software as a service, especially the sabre historically, you know would be a very accretive margin I mean, when you look out a few years for the composition of software within civil how large could that be.
Mark: Oh Boy again, you're asking me for it just because it's.
Mark: Very guidance that we're not ready to give that at this time, but obviously, we built we bought this business to grow it.
Mark: And I've been very happy with the order intake that we've had from customers. There's a lot of interest from key airline customers.
Mark: They see this.
Mark: And I've been.
Mark: Quite satisfied with the assumption that we had from day, one that people would be various airline specific will be very receptive for us, bringing six culture into this business and we're seeing I'd say customers that are basically moved away from legacy Sabre.
Mark: Once we bought it and that then with the efforts that we've had the customer outreach. The the product development. We've had the investment that we made a bid that they've come back to us. So look without giving you any precise decision on number I see this growing and I see.
Mark: That's a very strong interest in us delivering what we call our nextgen solution, which is software as a service and that's going to be pretty good for recurring revenue going forward. Obviously, we got to get through the the time it takes to move to on premise to a software as a service and there is a lot of theirs.
Mark: Theres a lot of history from other companies that do that but suffice to say that I'm very optimistic.
Mark: Yeah.
Great. Thank you.
Mark: Our next question comes from Anthony Valentini with Goldman Sachs. Please proceed.
Anthony Valentini: Hey, guys, you've got Anthony on for Noah today. Thanks, So much for taking my question.
Mark: Other.
Anthony Valentini: So I just wanted to ask on the defense business. You know, we're hearing from a lot of the U S defense primes that there they are shifting their strategy in terms of how they are bidding on contracts.
Anthony Valentini: [noise] away from fixed price and going more towards cost plus.
Anthony Valentini: Is that something that you guys are also implementing into your strategy can you just talk about that a little bit.
Speaker Change: Absolutely absolutely I mean look.
Speaker Change: The impact that we've had.
Speaker Change: Fixed firm priced contracts that it might.
Speaker Change: Our development type contracts.
Speaker Change: Going through the period that we've had through Covid has been very very good commensurately and impactful and we see them in our results and we're going to see them as we've talked about any of these legacy contracts now having said that we're going to work with our customers. All the time, so although we might not do that we're going to be imaginative and working with our customers to give you.
Speaker Change: An example that in some cases and we have entered.
Speaker Change: Two new contracts, where the government specific instead okay.
Speaker Change: We agree with you that we don't necessary necessarily have to take the cost to which have a lot of inflation related to revenue due to them and consider metal pass through contracts. So basically the cost to be what the cost will be so so yes. I think we are basically of were impacted by the same thing.
Speaker Change: That a lot of our legacy peers are across the industry and I think we're taking the same kind of actions.
Speaker Change: Okay. That's helpful. As a follow up there Sonya you had mentioned.
Speaker Change: 200 basis points basically like a drag from these challenge programs and then another 100 basis points.
Speaker Change: Like the overhead absorption. So if I just kind of use those numbers and that implies something like a seven 5% margin.
Speaker Change: What's remaining thats going to drive this business to get to those double digit percentages that you guys have historically talked about.
Well as I mentioned, it's really the ramp up of the new contracts that we've signed and especially those transformational one.
Speaker Change: They are large in size accretive.
Speaker Change: And they will have a meaningful impact on the margin as they ramp up they are really not.
Speaker Change: Nominal right now in terms of our results our revenues and so as those ramp up the they'll they'll have a more meaningful impact.
Speaker Change: Okay. Thanks, so much guys I appreciate the time.
Speaker Change: Thank you.
Speaker Change: Our next question comes from Jordan <unk> with Bank of America. Please proceed.
Jordan: Hey, good afternoon. Thanks for taking the question so just.
Jordan: Hopefully a final one on defense margins.
Jordan: With our double digit target.
Jordan: How confident are you in that timeline being 2025, where you start to see that accretion from new contracts.
Jordan: We still continue to operate under a continuing resolution for this year.
Jordan: Much downside risk to you guys look at if we go through sequestration.
Speaker Change: Let me let me just started off look again as I said.
Speaker Change: What we're talking about this quarter is no different that we've been talking about it.
Speaker Change: Certainly in the previous quarter, where we moved we argue admittedly move things out.
Speaker Change: What we're giving today is more precision specific on these legacy contracts that give you an idea of what this represents.
Speaker Change: By itself and also to give you a feeling that we're quite confident.
Speaker Change: In the core of this business. This is a strong business that will work through these legacy contract. So if I try to maybe give you a little bit more color specifically the question.
Speaker Change: There continues to be two pieces here the.
Speaker Change: The growth in the core business, which she is very strong and which is influenced by the ramp up in the transformative new business that we've talked about the 20% growth in the backlog that we've had last couple of years at the same time as the retirement of these legacy contracts, which dragging.
Speaker Change: Hence the overall margin.
Speaker Change: So we clearly see as we said before that there is going to be an inflation, where these two curves meet.
Speaker Change: And while we still predict is that something that happened in the latter half of next year. There's no change there, but I think may happen, but I think maybe where it gives me a little bit more precision as actual dragging it back in this quarter and introducing the fact that this isn't going to be linear theres going to be variability because of the spin.
Speaker Change: The actions that we're taking to retire risk, but depending on the timing of their private at risk at our efforts to retire them as quick as possible is going to affect us, but the trend the trend line driving inflection is the one we've been talking to is very much intact.
Speaker Change: Great. Thank you.
Speaker Change: Hello.
Speaker Change: Our next question comes from Faiza Lee with <unk> Brown. Please proceed.
Fai Lee: Oh. Thank you thanks for taking my questions Marc.
Fai Lee: Mark your.
Fai Lee: Three year EPS compound growth rate target hasn't changed from the mid 20% range and I know you don't aren't really when I talk about the two.
Fai Lee: 2025 guidance since you have a friday, but that target implies pretty strong growth next fiscal year and I just wanted to get a sense of how you see that target.
Fai Lee: Right now in terms of whether it's a stretch where you think you're pretty confident that you'll achieve it can you just maybe comment around that.
Fai Lee: Well I'm going to turn it over the Sony had a chance to that question I think a little bit a while ago, but look its got it.
Speaker Change: The bottom line is just we're not ready to give that guidance right now we'll give it at the same time a year, that's going to be next quarter.
But.
Sony: Clearly, it's going to be some dependency on the timing of the risk retirement defense and the pace of new programs ramping up when we actually sign these generation contracts such as the one fact that I talked about.
Sony: At the same time the outflow for civil remains very robust and you just saw the order intake that we signed this quarter on top of one three.
Sony: Over 1.3 on top of 20% growth in Italy in the.
Sony: And our revenue so.
Speaker Change: All of those have been factored anything you want to add the same now you've covered it and we'll provide more insights in Q4 like we usually do.
Speaker Change: Okay.
Speaker Change: And just another question on the defense outlook.
Speaker Change: It basically sounds like relative to your expectations and your outlook going forward and nothing more.
Speaker Change: It really changed from the previous quarter.
Speaker Change: And yet you've provided additional guidance the market's reacting very negatively or additional information on the legacy contract market's reacting very negatively around that what's your thoughts around you know how the markets interpreting.
Speaker Change: That additional information.
Speaker Change: Well long ago stopped predicting that one I don't think we do run our business and.
Speaker Change: Matt I know that repeat everything I said, but I feel very confident about that we have a business in defense.
Speaker Change: And I'll just go right to the point this is not a business thats broken. This isn't this is a business is growing with contracts are going to be accretive to the margin expectations. We have we have a lot of backlog in my experience in all my career.
Speaker Change: The one thing you want to have is backhaul because you have backlog as long as your backlog is profitable and it is profitable as profitable. The aim is that we have we're attacking very specific contracts here, they're all very similar although the contracts themselves are different they all point to the same kind of things pre COVID-19.
Speaker Change: Firm price and were attacked him with laser focus with dedicated tier teams while at the same time, not keep getting cheaper and align our eye off the ball of the hundreds of other contracts that we executed defense at any given time make sure we continue to execute execute donuts.
Speaker Change: On plan, which we fully expect to do so with all that.
Speaker Change: Yeah.
Speaker Change: That's basically forms my confidence.
Speaker Change: In the defense business, albeit we are where we are.
Speaker Change: Okay. Thank you.
Speaker Change: Okay.
Speaker Change: Okay.
Speaker Change: Thank you operator at this time.
Speaker Change: Operator, thank you given that were on the hour I'd like now to open the lines to members of the media should there be anyone with questions or mark or Sonya.
Speaker Change: As a reminder to register a question. Please press the one four on your telephone.
Speaker Change: Okay.
Speaker Change: Yeah.
Speaker Change: Okay.
Speaker Change: We have a question from Stephane <unk>.
Speaker Change: From that plus can adjourn. Please proceed.
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Speaker Change: Operator, that's all the questions we have I want to close the call here and thank all participants on today's call and remind you that a transcript will be available shortly on the website.
Speaker Change: Yeah, right now seems to be fine.
Speaker Change: Bob.
Speaker Change: Also for me constitutes you're all set up yet so it's the needs to the web.
Speaker Change: Yeah.
Speaker Change: Ladies and gentlemen that does conclude the conference call for today, we thank you for your participation and ask that you. Please disconnect. Your line. Thank you.
Speaker Change: <unk>.